Fed Has No Hammer, Uses Handsaw And Chisel To Pound Nails

The next time the Fed unleashes quantitative easing, maybe we'll finally wake up to the fact the Fed is not just powerless, it is actively destructive.

The Fed is promising once again to pound nails with the only tools in its toolbox, a saw and a chisel. The "nails" the Fed is trying to pound down are unemployment and deflation. Needless to say, whacking these big nails with a handsaw and a chisel is completely useless: they can't get the job done.

The Fed claims all sorts of supernatural powers to sink nails at will–"unconventional monetary policy," quantitative easing, money dropped from helicopters and so on. But all it really has are two tools which have no positive effect on unemployment or the real economy.

1. The Fed can manipulate interest rates to near-zero

2. The Fed can shove "free money" to the banks

That's it. That's all the tools the Fed has in its toolbox. Let's consider what these tools accomplish in the real world.

If capital cost 10% to borrow, only high-quality, low-risk ventures would attract funding or qualify for a loan. At 1% interest, the borrowing costs are so low that all sorts of high-risk, marginal schemes can afford to float loans.

Low interest rates also lead to money flowing to marginal borrowers. If rates were 10%, only those with good credit, credible income streams and collateral qualify for loans. At 1%, marginal borrowers (the kind who are most likely to default) qualify for loans.

All the Fed accomplishes with zero-interest rates is to build up a new wave of borrowers who will default. The Fed's policy simply adds to the mountain of impaired debt that is crushing the global economy.

The Fed's zero-interest rate policy (ZIRP) has impoverished savers and pension funds and provided disincentives to capital formation. In its anxious rush to lower the cost of borrowing, the Fed has stripped hundreds of billions of dollars of interest income out of the economy, and punished those who accumulate capital (cash savings) that is the bedrock of capitalism (a meaningless myth now that the Fed and Federal government are central-managing the economy).

Talk about unintended consequences. The Fed's ZIRP punishes the prudent and rewards financier gamblers and encourages marginal borrowers who are tomorrow's defaulters.

Pushing "free money" to the banks was supposed to do three things: It was supposed to enable the banks to lend lots of money at a premium and skim enormous profits that could be used to rebuild their ravaged balance sheets.

It was also supposed to spur consumption and investment, because money was so "cheap" how could you refuse to borrow more?

Lastly, it was supposed to enable homeowners to refinance their underwater mortgages at lower rates, creating disposable income that the homeowners would then spend on Chinese-made TVs, clothing, etc., creating "growth."

As Mish Shedlock often points out, you can't force people to borrow money, and offering marginal borrowers more debt does not make them magically creditworthy. The truth is that 95% of American households have taken on ever-rising debt loads while their adjusted incomes have been flatlined for decades.

The Fed's "solution" to over-indebtedness and excessive leverage is more debt and more leverage. Financial media lackeys and assorted analyst-toadies keep proclaiming that "households have deleveraged" and are now ready, willing and able to take on a couple trillion dollars more of debt to buy stuff, but this is the usual propaganda of cherry-picking data to fit the happy story being "sold."

The top 5% have improved their debt-income ratios, but the lower 95% don't qualify for new loans or refinancing. Now that the banks are weighed down with bad debt and writedowns, they are wary of loaning more to marginal borrowers.

So the Fed's "free money" that it shoved to the banks sits in reserves. It's dead money. It isn't funding wonderful new enterprises that are hiring millions of unemployed workers, it's sitting as reserves, bolstering balance sheets, or it's funding trading-desk speculations in the foreign exchange, stock and bond markets.

Maybe trading desks added a few traders to play with the Fed's "free money," but that's like hitting the unemployment nail with a handsaw blade: it doesn't do anything in the real economy or the labor market.

Fed Chairman Ben Bernanke's famous "helicopter" from which he drops money into the economy is a misnomer. He can't drop money into the real economy; all he can do is drop it into the banks, where it languishes as reserves or is used to fuel speculative bets in global markets.

The Fed is powerless, as its tools have no effect in the real world. It can fuel "risk on" market rallies with its trillions in "free money," but it can't lower unemployment or accomplish anything in the real economy except rob savers and pension funds of hundreds of billions of dollars each and every year.

It's actually, pathetic, isn't it? Ben and the rest of the impotent board are uselessly banging away at nails with their handsaws and chisels, while claiming to be financial wizards with unlimited powers. The next time the Fed unleashes quantitative easing, maybe the citizenry will wake up to the fact the Fed's only power–to steal from savers in order to benefit insolvent parasitic banks–is actively destructive.